Early 2020 AGM season update

The recent publication of annual reports by September year-end companies marks, once again, the imminent beginning of another AGM season for FTSE All-Share companies.  The 2020 AGM season is, with regard to triennial remuneration policy renewals, ‘on cycle’ and, as a result, a large proportion of companies will be seeking approval for new policies in 2020.

The revised UK Corporate Governance Code (‘Code’) took effect for accounting periods beginning on or after 1 January 2019.  It will be particularly interesting to see how those companies seeking approval for new policies in 2020 have sought to comply with the Code especially in relation to those newer areas of focus which have been ‘hot topics’ for many investors and commentators during 2019 (e.g. equalisation of executive director and workforce pension contributions and post-cessation shareholding policy).

The focus on executive remuneration continues to be intense and, while companies wrestle with issues such as how best to structure their remuneration arrangements to align pay with strategy (within the confines of what will be acceptable to shareholders) and how to comply with the Code, market practice in some areas is somewhat in a state of flux (e.g. the operation of ‘alternative’ incentive structures, such as restricted shares).  While there is uncertainty, the views of the major proxy voting agencies and the larger institutional investors will likely play a heightened role in shaping market practice over time.  It will be important therefore for Remuneration Committees to closely monitor how market practice and the views of shareholders and proxy agencies continue to evolve.

Against this backdrop we have taken a look at changes to directors’ remuneration policies and practices amongst the thirty-one September year-end companies which have published annual reports to date.

The key points:

• Structure

The large majority continue to operate a ‘traditional’ bonus plus performance share plan (‘PSP’) type structure. 

None of those companies seeking approval for a revised policy are proposing a significantly different approach to their existing incentive framework and all are continuing to operate a ‘traditional’ bonus plus PSP arrangement.  However, the one company putting forward a policy for the first time is introducing a single incentive scheme (structured as an annual bonus with significant deferral subject to underpins). 

Of the other September year-end companies (i.e. those not putting forward a new policy for approval), only one operates an ‘alternative’ LTIP structure (restricted shares) and one operates a bonus in isolation – the rest continue to operate a ‘traditional’ bonus plus PSP structure.

• Salary increases

Above workforce increases remain liable to criticism and require robust rationale, and salaries on appointment are also under the microscope. 

Broadly 25% of companies (seven out of the thirty-one) have awarded above workforce salary increases for some or all of their executive directors (although for one of these companies this was part of an overall rebalancing of the remuneration package).  Excluding the company rebalancing its package, two of these six companies awarded double-digit percentage increases (justified by ‘performance’ in one case and by ‘Group performance, pay of equivalent roles within comparable companies, performance and pay’ in the other).  One of these companies has received a vote against recommendation from ISS for the remuneration report as a result (the ISS report for the other company has not yet been published).

One company set the CEO’s salary on appointment at a 25% premium to the predecessor and this was a major factor in the resulting 44% vote against the remuneration report (ISS recommended a vote against).     

Where it is necessary to award such increases, both strong rationale and effective engagement is, in our experience, necessary.

• Variable pay quantum

Despite the difficulty of proposing increases in quantum, a significant minority of companies have done so.

Six out of the fifteen companies seeking approval for a new policy have proposed increases in variable pay opportunity – whether through an increase in LTIP only (three out of six) or a combination of LTIP and bonus (three out of six).  ISS has published voting reports for only half of these six companies so far and has provided an abstain recommendation on one and contentious vote for recommendations on the other two.  One of these six companies has so far held its AGM and this company, which sought approval for an increase to both bonus and LTIP opportunity received a significant (20%) vote against policy (primarily, it appears, as a result of these increases) (ISS had recommended shareholders abstain).

Any increase in the present context will be scrutinised closely.  However, while the reaction of the proxy voting agencies and shareholders to the other companies seeking approval for increases remains to be seen, early indications are, again, that provided the rationale is robust and linked to strong engagement, the voting agencies and shareholders may be willing to provide support (albeit qualified).

• Deferral and holding period

The strengthening of good practice features like bonus deferral and LTIP holding periods continues, particularly where increases to remuneration are proposed.  For example, one of the six companies proposing increases to incentive opportunity also proposed an increase to the proportion of bonus deferred. The other five already operate bonus deferral broadly in line with market practice.

There is a clear expectation that companies will operate bonus deferral and ISS, for example, will typically only provide qualified support at best on remuneration policies where this is absent. 

• In-employment share ownership guidelines

Most companies, following pressure in particular from ISS, have gravitated to share ownership guidelines of at least 200% of salary.  All but one of the fifteen companies seeking approval for a new policy in 2020 will now have a share ownership guideline of at least 200% of salary for all executive directors.  Five of these companies have proposed increasing the guideline level in 2020 to 200% of salary from below this level and one company has increased from 200% of salary to a higher level.  A number of institutional shareholders have published guidelines calling for higher guideline levels for larger companies and, in our experience, this is coming up in current consultations.

• Post-cessation share ownership guidelines

This was one of the ‘hot topics’ of 2019 and companies are continuing to wrestle with how best to adopt a post-cessation shareholding policy in order to (i) comply with the provisions of the Code (which leaves significant room for manoeuvre), (ii) take account of the evolving views of shareholders and proxy voting agencies (which range from the highly prescriptive and – some might argue – aspirational (the Investment Association) to the less tangible (ISS and Glass Lewis)) and (iii) take account of the views of those executives affected.

Of the fifteen companies seeking approval for a new policy, ten have introduced a specific post-cessation share ownership guideline linked to the in-employment guideline (with five of these companies applying the guideline to new awards only).  The remaining five companies have not gone this far and have taken a ‘lighter touch’ approach which simply introduces a formal policy by highlighting and bringing under one umbrella the existing approach to LTIP vesting/holding periods and bonus deferral, and how these interact with the good/bad leaver policies.

The approach taken by the fifteen companies is shown in the chart below:

The Investment Association will ‘amber top’ any policy that does not conform to its minimum expectations (i.e. the lower of the actual shareholding held at cessation and the in-employment guideline to be held for two years post cessation).  ISS and Glass Lewis have been clear that they expect post-cessation guidelines to be adopted but have been less prescriptive in how this should be achieved and this is unlikely to be a voting issue for 2020 (at least for companies staying with PSPs).  Based on the evidence to date, ISS will note where a post-cessation shareholding guideline is absent from the policy but, in isolation, this will not affect the voting recommendation.  However, in our experience, it is a voting issue for some institutional shareholders.    

• Pension contributions

This has been the hottest topic of the last few months and corporate governance officers seem to be adopting a tougher line by the week. The revised Code includes a new provision aimed at encouraging companies to align pension contribution rates for executive directors with those available to the workforce.  This was another area which fell under the spotlight in 2019 with, for example, a number of companies facing intense media scrutiny and some receiving significant investor opposition to remuneration-related AGM resolutions where there was a failure to reduce contribution levels for executive directors (where existing contribution levels were high relative to those of the workforce).

In order to move towards compliance with the provisions of the Code, and noting that this has become an important issue for many investors and the proxy voting agencies, all fifteen companies seeking approval for a new policy are either already aligned or have sought to address this issue in some way for 2020. 

The approach taken by the fifteen companies is summarised in the chart below:

Of the twelve companies addressing for future hires, eleven will have maximum pension contributions aligned with the workforce level and one has reduced to the level available to senior managers (which is higher than the workforce level).  The one company failing to reduce to the workforce level has received a ‘red top’ from the Investment Association and a contentious vote for recommendation from ISS for this reason.

There is also an increasing expectation that contribution levels for incumbents will be reduced to the workforce level over time (particularly where contributions are particularly high, e.g. 25% of salary or more).  While ISS’ published guidelines imply a more pragmatic approach to this issue than those of the Investment Association, it is interesting to note that one company has received a vote against policy recommendation from ISS as a result of a failure to sufficiently reduce the high contribution levels for incumbent executive directors which is evidence of the growing strength of feeling in this area.

The five companies addressing for incumbents are generally those where existing contributions are particularly high and there is thus significant pressure to reduce.  However, only one appears to have committed to reducing to the workforce level while the other four have made only partial reductions.

As for post-cessation shareholding guidelines, the Investment Association is taking a highly prescriptive line on pension equalisation (‘red top’ where there is a failure to set the maximum contribution level for new hires at the workforce level or where the current level for incumbents is 25% or more and there is no explicit commitment to reducing to the all-employee level by the end of 2022).  ISS and Glass Lewis have been less prescriptive to date but are focusing increasingly on this.

September year-end end companies may well have finalised their reports before the Investment Association guidelines were updated to call for all companies to commit to reducing incumbent executives to the all-employee level by the end of 2022 and to disclose both what that level is and how it has been calculated.  Accordingly, it is perhaps unsurprising that these companies did not reflect such points and we expect scrutiny to increase for December year-end companies.  

• Clawback and discretion

While not necessarily as explicit, it appears that companies are taking the opportunity to review their clawback provisions and their incentive arrangements more generally to ensure there is sufficient discretion (in line with the Code).

• Pay ratios

Disclosure of the pay ratio between the CEO and the workforce is mandatory for those companies with reporting periods beginning on or after 1 January 2019.  As a result, disclosure is not mandatory for September 2019 year-end companies.  Notwithstanding encouragement from investors for early disclosure, only eight of the thirty-one September year-end companies have published the ratio.

Of the eight companies publishing the ratio, six used method A (calculating the actual FTE remuneration for all relevant employees on the same basis as for the CEO), one used method C (reliance on an alternative existing data set) and one did not disclose which approach had been taken.

If you wish to discuss anything arising from this briefing, please ask your usual contact at FIT or call us on 020 7034 1111 or email us at Info@fit-rem.com.

This paper is intended to be a summary of key issues but is not comprehensive and does not constitute advice. No legal responsibility is accepted as a result of reliance on the contents of this paper.

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